article 3 months old

The Great US Gold Shortage

Commodities | Aug 26 2008

By Greg Peel

The following appeared at the top of major US bullion dealer Kitco’s website last night:

“IMPORTANT NEW NOTICE: Demand for bullion products has increased significantly in recent days. As a result, we may experience delays in supply and possibly delays in processing and shipping by our vaults. We apologize for this inconvenience and will do everything in our power to service your orders as quickly as possible. While cancellation fees still apply, prices are guaranteed regardless of the length of the delay. We remain committed to providing you the best service no matter what market conditions prevail.”

The reason for the delay is that last week the supply of one ounce American Eagle gold coins ran out in the US due to unprecedented demand, a development to which our Editor alluded to in his most recent Rudi On Thursday column. Finding itself caught short on coin blanks, the US Mint was unable to supply dealer orders for the coins and dealers were forced to simply put customers on a waiting list. It is the first time the Mint has stopped selling the particular coins since their introduction 20 years ago.

As of last night, the Mint has announced it will recommence supply, but only on a rationed basis to dealers. The rationing requirement is put down to “overwhelming demand”. Gold dealers are furious. This is, after all, how they make money. As the notice above suggests, Kitco, for one, has been forced to honour gold prices prevailing as orders were placed in a goodwill gesture to clients, thus taking the risk on the price at delivery.

Two questions immediately arise from this development. The first is: Why has demand for American Eagles suddenly surged to record levels? The second is: The Mint never had any problem supplying coins when the gold price was running up hard, why the problem when it has fallen hard?

The first point to note is that American Eagles are made only from US-produced gold. The second point to note is that dealers such as Kitco also sell other forms of gold coin, as well as gold bars, and also other “precious” offerings in silver and platinum. Yet for some reason everyone only wants the one ounce coins and nothing else. It is not clear why, although one might suggest that as the gold price is quoted as US$/oz, the value of a one ounce coin is most easily tracked.

Yet this is not just a US gold phenomenon. Dealers in Canada and Switzerland, for example, are also having difficulty filling retail orders for gold. And reports out of India suggest that jewellery-makers are also finding it very difficult to get their hands on any gold at these prices because Indian banks are having lines of credit refused by bullion banks for the purpose of gold delivery. Is this a credit crunch effect? If so, surely genuine orders for gold from jewellery-makers backing Indian bank requests are a secure enough reason to keep up supply. Gold is not a mortgage.

As to the reason for a sudden demand surge, it happened to coincide with the Russian invasion of Georgia. This invasion also occurred at the time when the gold price passed through US$800/oz on the downside on its fall from US$1030. It is not easy to say whether the increased demand was a fearful response to the potential of a new Cold War, or just a price level trigger. In the case of the former, the reaction from the gold price on the invasion was actually muted. As one cynic suggested, no one cares that much about Georgia.

Yet at the same time, the price of gold has been falling solidly since the US dollar began to stabilise and rally. The rally is largely due to the weakening of other world economies, as the financial market fear that took gold to US$1000 in the first place has not exactly abated in any meaningful way. The US dollar remains, however, relatively strong.

One could argue that the reason the gold price hasn’t leapt up much from its lows despite strong demand is simply because no one can actually buy these coins at the moment. Perhaps the price should be much higher. But that would be to make the mistake that the physical market for gold is actually a large one.

For as far as commodity markets go, and all financials markets more so, the physical gold market is tiny – very tiny – compared to say base metals or particularly oil. Yet the total market for gold is enormous. This is because gold is very scarce, its supply is constantly dwindling, and 70% of each year’s production ends up being turned into jewellery while what remains in the world is mostly in central bank vaults. But at the same time gold is a popular instrument to trade as a hedge against inflation and geopolitical risk. It’s just that gold mostly trades on paper – via futures, other derivatives, and gold loans.

On that basis, demand for actual coins is never going to be able to push hard against the paper market in terms of price setting. Yet this still does not answer the question as to why, when the gold price has fallen from US$1000 to US$800, the US Mint’s supply of gold for coin production has suddenly dried up. Surely one might expect this to happen when the gold price is surging, not falling.

The Mint is simply shrugging and suggesting it was caught off guard. But there are other theories.

One is that the US government is a lot more concerned about what Russia is now up to than the rest of the market appears to be. Russia knows that it currently has the US on its knees – not through military might, but through financial displacement. With a war in Iraq still draining the coffers and the bail-out of the local mortgage market costing more and more each day (note that Russia is also a big holder of Fannie and Freddie bonds) Russia has seen an opportunity to re-establish a bit of global leverage after its Yeltsin-era demise. If there’s one thing Russia has plenty of, it’s oil, and subsequently cash. Why fight a Cold War with a nuclear arms race?

On this basis it has been suggested the US government is looking to shore up its gold positions, which means not letting any of the actual metal go unnecessarily. However, such a theory only plays into the hands of the supporters of GATA, who have long suggested the gold paper market has been manipulated by the US and other governments for decades. GATA claims there is actually a lot less gold bullion being held by Western central banks than disclosed by the IMF each year. Even the IMF is prepared to agree that gold lending renders its inventory assumptions potentially misleading.

GATA has now suggested that this gold coin embargo is the strongest proof yet its theories are correct. If so, the subsequent theory is that the gold price should really be higher – much higher. A lot more than US$1000/oz.

It will now be interesting to see just how quickly the US Mint can return to normal supply.

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms